Why the Fed wants to hike rates sooner rather than later
The main reason to begin raising interest rates in the US sooner rather than later is because of the healthy employment situation. But it is also about the ‘emergency’ policy setting that is no longer required.
The table below shows key US economic indicators and the real Fed funds rate at the start of the last four tightening cycles compared to now.
Conditions at start of Fed rate tightening cycles
In terms of its dual mandate, the core PCE inflation is 0.9% below the average of the last four tightening cycles, but this is offset by the unemployment rate which is 0.5% below average. However, the real Fed funds rate is 2.6% below the average rate at the beginning of the last four tightening cycles (-1.1% now vs 1.5% average). In other words, monetary policy is on emergency settings.
The other economic indicators (headline CPI, ECI, GDP) are all softer than the historical average, but not by 2.6%.
On this simple historical comparison that makes no assumptions about ‘natural’ or ‘normal’ conditions, a 1% hike in the Fed funds rate (right now) would bring the variance between the economic indicators and the real Fed funds rate closer to the historical average.
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